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Project financing techniques date back to at least 1299 A.D. when the English
Crown financed the exploration and the development of the Devon silver
mines by repaying the Florentine merchant bank, Frescobaldi, with output
from the mines. The Italian bankers held a one-year lease and mining
concession, i.e., they were entitled to as much silver as they could mine
during the year. In this example, the chief characteristic of the project
financing is the use of the projects output or assets to secure financing.
Another form of project finance was used to fund sailing ship voyages until
the 17th century. Investors would provide financing for trading expeditions on
a voyage to voyage basis. Upon return, the cargo and ships would be
liquidated and the proceeds of the voyage split amongst investors. An
individual investor then could decide whether or not to invest in the sailing
ships next voyage, or to put the capital to other uses. In this early example
the essential aspect of project financing is the finite life of the enterprise.
Project financing has evolved through the centuries into primarily a vehicle
for assembling a consortium of investors, lenders and other participants to
undertake infrastructure projects that would be too large for individual
investors to underwrite. The more prominent examples of the project
finance are:1. Road & bridges-Highways, Expressways and Seaways
2. Metro rails and other mass transit systems
3. Dams Multipurpose irrigation system
4. Railway network and services- both passenger and cargo
5. Power plants and other charged utilities- Solar power
6. Port and terminals
7. Airport and terminals
8. Mines and natural resource explorations, mineral processing
9. Pipelines and refineries
10.
Large residential and commercial buildings
11.
Large new industrial townships
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Definition
Project finance
Special purpose vehicle facilitate
assets securitization
Highly leveraged
Corporate finance
Corporate
obligation
secured debts
DER 3:1 NORMAL
and
greater disclosure
Soundness of project cash flow
and risk assessment
the
Allocated risk- Because many risks are present in such transactions, often
the crucial element required to make the project go forward is the proper
allocation of risk. This allocation is achieved and codified in the contractual
arrangements between the project company and the other participants. The
goal of this process is to match risks and corresponding returns to the parties
most capable of successfully managing them. For example, fixed-price,
turnkey contracts for construction which typically include severe penalties for
delays put the construction risk on the contractor instead on the project.
Costly - Raising capital through project finance is generally more costly
than through typical corporate finance avenues. The greater need for
information, monitoring and contractual agreements increases the
transaction costs. Furthermore, the highly-specific nature of the financial
structures also entails higher costs and can reduce the liquidity of the
projects debt. Margins for project financings also often include premiums for
country and political risks since so many of the projects are in relatively high
risk countries. Or the cost of political risk insurance is factored into overall
costs.
Project finance: when and why?
Given the aforesaid discussion the advantages of project finance as a
financing mechanism are:1. It can raise larger amounts of long-term foreign equity and debt
capital for a project.
2. It protects the project sponsors balance sheet. Through properly
allocating risk, it allows a sponsor to undertake a project with more
risk than the sponsor is willing to underwrite independently.
3. It applies strong discipline to the contracting process and operations
through proper risk allocation and private sector participation.
4. The process also applies tough scrutiny on capital investment
decisions.
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